Currencies are usually traded in specific amounts called lots. A standard lot is 100,000 units, although mini-lots and micro-lots — of 10,000 units and 1,000 units, respectively — are available. Because currencies tend to make small market movements, large lot sizes are needed to see significant profits or losses.
Forex traders make money when currencies change value. A point in percentage, or a “pip,” is the smallest increment a currency can move and is the fundamental unit for measuring currency trades. Usually, this number is $0.0001 when looking at pairs that include US dollars. So, if the euro-to-US dollar pair moves from 1.1518 to 1.1520, it’s moved two pips. If you don’t understand the pip value, it’s hard to adequately assess trading risk. For more on pips and pip calculations, The Balance, a website with the goal of making personal finance easy to understand, has some great insight.
There will usually be a difference between the bid price (how much a broker will pay for a currency) and the ask price (the price for which a broker will sell a currency). The difference between these prices is called the “spread,” and the wider it is, the more expensive it is for traders. So, if a bid-ask quote says EUR/USD = 1.3846/1.3849 the difference is three pips. If you “buy” into this trade, you’ll enter the market at 1.3849 and need the market to move at least three pips to be able to “sell” at a profit.
4. Exchange Rate
The goal of forex trading is to buy a currency low and sell when it’s high. The exchange rate lets you know the value of one currency as it relates to another. For example, if the CAD/USD = $0.75, then one Canadian dollar is equal to 75 US cents.
5. Cross Rate
This one’s a little trickier as it has a technical definition and an informal one. Technically, a cross rate is the exchange rate of two currencies, neither of which is the official currency of the country where the quote was given. For example, if you look at The Wall Street Journal, an American newspaper, for the euro-to-Japanese yen quote, that would be a cross rate. However, as Investopedia clarifies, many times cross rate is simply understood as any currency pair that does not include USD. The Associated Press defines cross rate still differently: “The rate of exchange between two currencies calculated by referring to the rates between each and a third currency.”
To trade currencies, you must deposit money into an account. This is your balance. Margin is the amount of your balance needed to open a new position (trade). It’s important to know that you don’t need to put up the full amount of a trade you wish to make — only a certain portion defined by your broker. That portion is the “margin requirement,” and it’s made possible by acquiring leverage. Stick with us here.
So what’s this magical leverage we’re talking about? In general, leverage is the ability to use other people’s money to enter a transaction. In forex trading, leverage is offered by brokers as a loan sometimes as high as 200 to 1. Let’s say I want to trade $100,000 of currency. The broker requires a margin of 1 percent and will offer leverage of 100 to 1. This means that I can make the trade using only $1,000 of my $10,000 balance, secure the $100,000 trade and still have $9,000 available in my account for additional positions. For further useful margin jargon, look at babypips.
Starting out in the forex world can be a little like getting on a bike for the first time mixed with learning a new language. By putting in a little time up front to learn the lingo and understand the bigger picture of how this market works, you can get comfortable and start trading with confidence.